This is an entirely free service. No payments are to be made. Also send me The Ultimate Guide to Profiting From Derivatives and sign me up for Profit Hunter,a free newsletter that focuses on identifying short term money making opportunities.Download NowSubscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.

Are companies ready for a recovery?

Are the companies you have invested in ready for a recovery? Well, we are not oracles to predict the much awaited recovery from recession. Newspapers all around are replete with talks of early signs of recovery, green shoots and also the opposite. Financial report-card for the June quarter for India Inc. bettered expectation, showing some signs of stabilization if not absolute revival.

Recovery or no-recovery, businesses can ignore neither of the scenarios and in fact need to prepare equally well for both.

A recent article in Mckinsey Quarterly discussed how the chief financial officers of businesses can assess the well-being of their firms and their readiness for a recovery from global slowdown. This article treads the same line and suggests investors how to evaluate the game-plans of the companies they have invested in for the recovery, which will happen sooner or later.

What will be the pace of recovery?
Different businesses have different industry cycles and therefore will behave differently in terms of speed and nature of recovery.
The recovery itself can be only short-lived with economy seeing a slump again what in the economics parlance is called a 'W' shaped recovery. It is evident from the general trend observed in the Indian stock market since last few months that choice of sectors and proper diversification will play an important role in deciding the magnitude of returns that can be generated from the markets.

Example: It is usually seen that the banking and financial services sector and technology start riding the recovery wave sooner than the more capital intensive sectors like automotive and real-estate. Sectors like FMCG and healthcare are a little immune to the economic fluctuations on account of the very nature of their business.

Note: IT sector appears as an aberration to this rule as Indian IT sector is closely coupled with the US and European well-being and is not driven much by domestic demand. However, leaders in this sector like TCS, Infosys and Wipro have seen a decent rally in the stock prices on account of better than expected financial performances during the last quarter.

Is the cost structure of company adequate for recovery?
Over-capacity is a bane in times of recession as well as in times of early recovery. Crises bring an opportunity to rationalise cost structures through better negotiations with employees, suppliers, unions as well as government. This advantage is usually lost once revival begins. Companies that slashed excess fat well in time, stand to gain more.

Example: A classic example for this is the IT sector, where companies like TCS, Infosys and Wipro were able to retain their operating margins through cutting employee costs, sales and marketing expenses and better onsite-offshore mix, in spite of immense pricing pressures from the clients.

How nimble is the supply chain?
An urgent need for cutting costs, capacity and working capital, usually leaves organisations too anemic to respond when the demand returns suddenly. Nimbler the supply chain, the faster the company will react to any increase in demand, gaining more market share.

Example: Healthcare companies like Cipla and Dr Reddy's that maintained their R & D expenditure despite the global recession will be better prepared for the recovery.

What are the plans for organic and inorganic growth?
Recession usually brings plethora of suitable undervalued acquisition targets which can catapult firm's growth once the recovery happens. Equity valuations, which are usually a leading indicator of fundamental recovery, bless the ones who act cautiously but fast.
Also, well-timed strategic alliances and joint-ventures in-sync with the firm's vision will propel future growth. No surprise that the bidding-arena of mergers and acquisitions has been vibrant in the last couple of quarters.

Example: Acquisition of Imperial Energy, a UK based Oil and Gas Company by ONGC Videsh for US$ 1.9 bn and acquisition of Wyeth by Pfizer, world's leading pharma company are a couple of cases in point. Negotiations between Bharti and MTN, Britannia's plans to raise Rs 20 bn for funding acquisitions, suggests that more of such M & As are in the offing.

Are the lessons learnt from the failures?
Downturn may beat some business segments out of shape. The firms that learn from the mistakes they or their competitors commit, usually divest from underperformers and focus on growth areas. Over dependence on a particular geography, market segment and currency is a dangerous from long term perspective.

Example: Increased attention to the Asia-Pacific and Middle-east markets by the IT and automobile companies, rural focus of the FMCG and telecom companies and more cautious approach towards riskier loans by the banking sector suggest that businesses do learn from mistakes. Invest in companies that learn these lessons sooner and respond quickly. Also, FMCG firms like Marico and Dabur which were more concentrated in the domestic market, are expanding in the newer geographies like Middle East and South Africa.

Is the company financially ready for a recovery?
Recovery might mandate building up of new capacity, product line or distribution channel which will result in immediate need of capital. Envisioning a recovery, as a wise move, many Indian companies are keeping their finances ready.

Example: Companies that are raising money either to retire their old debts (like Tata Motors for funding JLR acquisition) or invest in future endeavors (like NHPC and Mahindra Holidays issued new shares through IPOs) will be better placed once the demand revives. Tata Motors has unveiled plans to raise Rs 80 bn of funds for capital expenditure on new product development over the next 3 to 4 years.

Did the company milk the benefits that crisis brought?
Recession usually brings decreased inflation i.e. there is softening of cost in the market for human-resource, sales and marketing endeavors, research and development. Companies that are too fixated on cutting costs, usually miss out on this opportunity as factor cost shoot up once the recovery begins.

Example: While most sectors saw a rampant headcount reduction during the last few quarters, companies like eClerx, a leading Indian KPO, taking advantage of the soft-job-market revamped hiring at higher management levels. Media-deflation helped FMCG companies like HUL and Godrej Consumers in revamping their sales and marketing efforts which will help in reinforcing their brands.

What are the potential risks of the upturn?
Lastly, an upturn usually results in a lot of changes in the business environment in terms of target segments, customer preference, business models, technology and delivery and distribution mechanisms. There is a lot of risk involved in terms of health of markets for raw-materials and finished products, currency volatility, international trade and government regulation. Investors need to understand the risks involved as well as their possible mitigation before investing in a business.

Example: On the currency volatility front, while many companies like 3i-Infotech, Reliance communications etc, repurchased and cancelled FCCB debt at a discount, others are watching their hedge positions very keenly to cut back on forex losses.

Friedrich Nietzsche, a famous German philosopher has said “That which does not kill us makes us stronger”. Nothing can be truer about an economic crisis.
As the recovery will start to happen in due course of time, investors will do well to keep an eye on their investments and allocate funds to
companies which will emerge stronger from the downturn, disinvesting from those which are overvalued currently and will lose sheen once economic revival occurs.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.